What are Angel Investor: Definition, Characteristics, Advantage

Many people have dreams and aspirations to start their own business. While one could manage to save and invest their own capital to get their business up and running, the capital requirements could increase as the company grows. In such cases, entrepreneurs could take a loan to meet the capital requirements or turn to angel invesos who play a crucial role in nurturing the startup ecosystem. In this blog, we will explore more about angel investors and their role in the growth of early-stage businesses.

Who are Angel Investors

Angel investors are individuals who help with financial backing to startups and early-stage business in return for equity ownership. They also offer guidance and industry connections, becoming valuable allies for ventures.

Unlike a venture capital fund, angel investors use their personal wealth to invest with an expectation of high returns with the hope of exiting in the future at a significantly higher valuation through an acquisition or initial public offering (IPO).

Characteristics of Angel Investors

Let’s look at some of the key characteristics of angel investors:

• Angel investors are seasoned professionals from various fields and have deep domain expertise
• Senior executives, CEOs, and experienced professionals engage in angel investing since due to their expertise in driving the business’ success
• Successful entrepreneurs and high net-worth individuals make angel investments as part of their portfolio strategy
• Angel investors accept significant risk when investing companies that are in the early stages as the likelihood of the business failing is generally high

How Does Angel Investing Work

The term ‘angel investing’ originates from the Broadway theatre world. Instead of formal lenders like banks, wealthy individuals used to finance stage productions. The patrons were seen as ‘angels’ as they accepted the risk despite having no guarantee of return.

Similarly, angel investors provide their own wealth in startups in exchange for ownership equity. Despite the inherent risk, an angel investor does not expect repayment of the seed fund but aims to generate returns higher than traditional investment avenues.

Process of Angel Investing

• Connecting with Angel Investors

For startups, angel investors play a vital role, especially in the early growth stages. Startups or individuals can find angel investors within their personal networks, angel investing networks or groups, and online platforms. Alternatively, directly contacting known angel investors or entrepreneurs can also help with angel investing.

• Due Diligence

Due diligence is an integral part of the investment process. Before committing to any funds, the investor carefully assesses the proposal of the business. This includes evaluating the management, business model, product-market fit, financials and long-term potential of the startup.

• Investment Agreement

Once a startup clears the due diligence process, an investment agreement or term sheet is drafted which ouylines the investment amount and equity ownership, governance rights and other terms.

• Deal Finalisation

Once the investment agreement is reviewed and approved, the angel investor and startup sign the agreement which is formalised through legal documentation. This process completes the angel investment process and makes the deal official.

Angel Investor vs Venture Capital

Let’s take a look at the key differences that can help us distinguish between angel investors and venture capital.

Accreditation of Angel Investors According to SEBI

At present, the Securities and Exchange Board of India (SEBI) mandates that angel investors are required to invest at least ₹25 lakhs in venture capital undertakings. Also, the maximum cap for investment is ₹10 crore in any single startup.

However, SEBI recently released a consultation paper proposing changes to the angel fund network. Angel funds are categorised under Alternative Investment Funds (AIF) that pools money from investors to fund early-stage startups.

As per the consulaltation paper, SEBI proposed that the funds should only onboard accredited investors to ensure that they are aware of the risks involved when investing in startups. Also, the accredited investors are required to have an annual income of at least ₹2 crore or more, or have a net worth more than ₹5 core with a minimum annual income of ₹1 crore.

Advantages of Angel Investors for Startups

• Angel investors are highly beneficial for startups as they help with fundraising when the company is in the ideation or early growth stage and does not have access to traditional sources of funds.
• They may continue to infuse more capital in the future to support the startup on their growth journey.
• They are usually well-connected and help the company connect industry contacts, customer referrals, or potential investors.
• They bring in domain expertise and industry insights that a startup can leverage.
• Having an angel investor can help the company improve its credibility and trust among future potential investors, partners and clients.

Risks & Challenges of Angel Investing

While angel investing has the potential to generate attractive returns, one should be aware of the risks associated.

• Angel investing carries significant risks. There are high chances that a startup could start underperforming, increasing the risks of investing.
• Due diligence can be a challenging process since it is difficult to assess the financial health and management of a company witth limited historical data. Moreover, if a startup is operating in an upcoming segment, there is little data to refer to.
• Angel investing also has tax implications which an investor should be aware of before making an investment.
• For startups, angel investing can be disadvantageous in cases where the investor requires significant equity and more control in the company’s operations.